Risk management at forefront as farmers face uncertainty in 2013

One thing is certain for corn farmers in 2013, and that is the importance of risk management amid extreme uncertainty in yields and revenues, Purdue agricultural economist Chris Hurt says.

Three years of below-normal corn yields and ongoing drought in the western Corn Belt have the potential to drive corn prices to record highs in the coming year, but a return to more normal yields nationwide could send corn prices on their largest-ever year-to-year decline. The wide range of possibilities makes growers vulnerable and emphasizes the need for a variety of risk management tactics.

"The key to risk management is to protect against the potential bad outcomes, but still leave opportunities to capitalize on potential good outcomes," Hurt said.

The first way to do that is with crop insurance. Farmers can choose from a variety of coverage types and levels that offer financial protection from low yields and prices. What makes crop insurance so desirable is that it doesn’t limit the revenue a grower can receive if yields or prices are high.

"Crop insurance is hugely important," Hurt said. "Sometimes growers are hesitant to sign up because the premiums have to be paid regardless of whether coverage is used. But I think a lot more people understand the value after the drought this year. If not for crop insurance, it would be depression in many farming communities right now."

Marketing decisions also play a role in risk management. Many farmers forward-contract portions of expected crop production to lock in forward prices. But while forward contracts protect growers from falling prices, they also prevent gain if prices increase between the times contracts are made and when crops are harvested.

"Growers should forward-contract only a portion so that if prices go up they still have money to gain," Hurt said. "It's common to forward-contract 25-30% of expected production for new crop delivery."

Farmers who do forward-contract also can consider purchasing an out-of-the-money call option against their forward contracts. The option allows the opportunity for farmers to gain revenue if prices go up after contracts are made.

An example, Hurt said, is a farmer who opts to sell corn for $6 per bu. in a forward contract. By purchasing a call option on futures at $7.50 per bu., the farmer could add $2.50 a bu. to their $6 if corn prices ended up moving to $10 because of drought.

"The call option costs some money but provides upside opportunity in case prices move sharply to the up side," he said.